The government is proposing to cut the price of the BT cotton seeds (Bollgard II) from Rs 800 to Rs 740 per packet (450gm packets). While the move would provide some respite to cotton farmers, it stands to eat away margins of seed companies.

In a bid to provide relief to cotton farmers and retain cotton acreages, the government has recently proposed a reduction in the prices of BT cotton seed packets (hybrid cotton seeds) to help farmers’ access quality cotton seeds at reasonable rates. While on one hand, the final approval of the move stands to benefit, retain and provide respite to cotton farmers who have been severely hit by pink bollworm attacks in last two consecutive years. On the other hand, it stands to impact the net realizations for seed companies who have been seeing troubled times with increasing pressure on margins. In this article, we discuss and analyse the impact of the proposed move on various stakeholders.

The proposal –

The government is proposing to cut the price of the BT cotton seeds (Bollgard II) from Rs 800 to Rs 740 per packet (450gm packets). Parallel to this reduction, there would also be a Rs. 10 per packet reduction in the royalty paid to technology provider Mahyco Monsanto Biotech Ltd. So this is essentially a Rs. 50 per packet reduction in the net realizations for the seed companies.

Over the past years, there have been heightened disputes about cotton seed prices and royalty payments to the technology providers, to an extent that Mahyco Monsanto Biotech Ltd has backed off from providing any new technology to India.

In 2016, the government had cut the royalty payment to technology providers by almost 74 percent, from Rs 163 to Rs 43 per packet. Along with this the prices of cotton seeds charged to farmers was capped at Rs 800 per packet from the earlier approximate Rs 900-1000. The current proposal stands as a second move in past two years towards reduction of the seed prices with a proposed a 7.5 percent further cut.

The farmer’s side –

In the last two years, cotton fields have been severely impacted by the pink bollworm which has resulted in crop damage and severe losses for cotton farmers. The current cut stands to reduce input costs for farmers, help retain cotton acreages and ensure deeper penetration of high quality seeds thereby reducing worm attacks.

The industry side –

While the current cut stands to benefit and support around 8 million cotton farmers in India, it is being largely criticised by the National Seed Association of India (NSAI), who highlights that the margins in the cotton seed business are already under pressure due to increased labor and input costs and any such cut would further hamper the overall profitability of the business as a whole. Moreover, the association proposes an increase in prices for seed packets and warns of seed scarcity in the event of price cuts which would rather give way to low quality seed manufacturers.

The impact –

The industry size of cotton seeds stands at around 50 million packets per year (it stands at 47 million packets for the year 2017- 18). With a Rs 50 decrease in net realizations, this essentially means a total hit on earnings to be around Rs 250 crore for the total topline of cotton seed companies and around 50 crore net reduction in total royalty payment to the seed technology company Mahyco Monsanto Biotech Ltd.

Impact on companies –

Companies like Kaveri seeds, whose majority revenue is dependent on the cotton seed sale are positioned to get impacted by this move. Cotton seeds form almost 60 percent of the business for Kaveri seeds – an approximate 7 million packets per year. With 2018 almost getting closed, the topline is expected to be impacted by around Rs 35 crore in 2019, approximately 5 percent of 2017 revenue. This would result in a squeeze on margins as well.

Over the past years, the company has been talking about shifting focus from the high volatility cotton seed business to high margin vegetable seed business and now targets to make vegetable seed business almost 55 percent of total revenue in coming years. However, the move would only be gradual over the years and the benefits would take significant time to reflect in profitability.

Outlook -

On the news of the current proposal the Kaveri seeds stock has corrected 8 percent in the last 2 days and is now trading at a 2019E PE of 12x and an 2019E EV/EBITDA of 8.3x.

With the approval of the current proposal, realizations stand to be impacted in the upcoming year 2019. Moreover, with consecutive breakout of the pink bollworm issues in Punjab and Maharashtra, there is an expectation of a shift in cotton acreages in the upcoming Kharif season which would impact volumes and further impact the topline.